I want
to follow-up on an article Paul Krugman published a few days ago in the
NYT, Myths
of Austerity:

When I was young and naïve,
I believed that important people took positions based on careful
consideration of the options. Now I know better. Much of what Serious
People believe rests on prejudices, not analysis. And these prejudices
are subject to fads and fashions.

Which brings me to the
subject of today’s column. For the last few months, I and others have
watched, with amazement and horror, the emergence of a consensus in
policy circles in favor of immediate fiscal austerity. That is, somehow
it has become conventional wisdom that now is the time to slash
spending, despite the fact that the world’s major economies remain
deeply depressed.

This
conventional wisdom isn’t based on either evidence or careful analysis.
Instead, it rests on what we might charitably call sheer speculation,
and less charitably call figments of the policy elite’s imagination —
specifically, on belief in what I’ve come to think of as the invisible
bond vigilante and the confidence fairy.

Bond
vigilantes are investors who pull the plug on governments they perceive
as unable or unwilling to pay their debts. Now there’s no question
that countries can suffer crises of confidence (see Greece, debt of).
But what the advocates of austerity claim is that (a) the bond
vigilantes are about to attack America, and (b) spending anything more
on stimulus will set them off.

What reason do we have to
believe that any of this is true? Yes, America has long-run budget
problems, but what we do on stimulus over the next couple of years has
almost no bearing on our ability to deal with these long-run problems.
As Douglas Elmendorf, the director of the Congressional Budget Office,
recently put it, “There is no intrinsic contradiction between
providing additional fiscal stimulus today, while the unemployment rate
is high and many factories and offices are underused, and imposing
fiscal restraint several years from now, when output and employment
will probably be close to their potential.”

Nonetheless, every few months we’re told that
the bond vigilantes have arrived, and we must impose austerity now now
now to appease them. Three months ago, a slight uptick in long-term
interest rates was greeted with near hysteria: “Debt Fears Send Rates
Up,” was the headline at The Wall Street Journal, although there was no
actual evidence of such fears, and Alan Greenspan pronounced the rise a
“canary in the mine.”

Since then, long-term rates have
plunged again. Far from fleeing U.S. government debt, investors
evidently see it as their safest bet in a stumbling economy. Yet the
advocates of austerity still assure us that bond vigilantes will attack
any day now if we don’t slash spending immediately.

But
don’t worry: spending cuts may hurt, but the confidence fairy will take
away the pain. “The idea that austerity measures could trigger
stagnation is incorrect,” declared Jean-Claude Trichet, the president of
the European Central Bank, in a recent interview. Why? Because
“confidence-inspiring policies will foster and not hamper economic
recovery.”

What’s the evidence for the belief that fiscal
contraction is actually expansionary, because it improves confidence?
(By the way, this is precisely the doctrine expounded by Herbert Hoover
in 1932.) Well, there have been historical cases of spending cuts and
tax increases followed by economic growth. But as far as I can tell,
every one of those examples proves, on closer examination, to be a case
in which the negative effects of austerity were offset by other
factors, factors not likely to be relevant today. For example,
Ireland’s era of austerity-with-growth in the 1980s depended on a
drastic move from trade deficit to trade surplus, which isn’t a
strategy everyone can pursue at the same time.

And current examples of austerity are
anything but encouraging. Ireland has been a good soldier in this
crisis, grimly implementing savage spending cuts. Its reward has been a
Depression-level slump — and financial markets continue to treat it
as a serious default risk. Other good soldiers, like Latvia and
Estonia, have done even worse — and all three nations have, believe
it or not, had worse slumps in output and employment than Iceland,
which was forced by the sheer scale of its financial crisis to adopt
less orthodox policies.

So the next time you hear
serious-sounding people explaining the need for fiscal austerity, try
to parse their argument. Almost surely, you’ll discover that what
sounds like hardheaded realism actually rests on a foundation of
fantasy, on the belief that invisible vigilantes will punish us if
we’re bad and the confidence fairy will reward us if we’re good. And
real-world policy — policy that will blight the lives of millions of
working families — is being built on that foundation.

Krugman
also appeared
on CNN's Fareed Zakaria stating that more needs to be done to shore
up the economy in the form of spending on public works and other
programs. On the flip side, Mr. Zakaria interviewed Harvard economic
historian Niall Ferguson who thinks we need to stop spending and
"radically simplify the tax code" to shore up business confidence. I embedded the video with both interviews below and will go over a few key points.

Second, Krugman is right
that austerity will work against governments trying to shore up their
fiscal position. Why? Because if austerity slows the recovery, or worse
still, kills it, then governments will see their tax revenues shrink
dramatically. Imposing austerity measures during a fragile recovery is
akin to engaging in fiscal suicide.

Third, Krugman is right
about Ireland, Latvia and Estonia. They all implemented savage cuts,
unemployment went up, as did the cost of insuring their debt, and
government revenues dwindled. It has been nothing short of a monumental
disaster.

Fourth, "invisible bond vigilantes" do not pose a
serious threat for the US or even Japanese bond market. Bond vigilantes
can easily pick on Greece, Portugal and maybe even Spain, but that game
has run its course too. The Europeans finally woke up and sent out a
strong signal to speculators in the form of a trillion
dollar gamble.

Importantly, the
big, bad bond vigilantes are simply no match for the Federal Reserve and
they know it. Bernanke can squash them like a bug if they get too smug
and start speculating on US sovereign debt.

Fifth, as I wrote in
my last comment, the bond market is more
worried about a 1930s echo right now, which is driving yields
lower. If they were more worried of massive fiscal crisis leading to a
run on the US dollar, then yields would be skyrocketing up, not down.

Sixth,
I do not agree with all of Krugman's proposals. Spending on public
works is not a long-term solution to bolstering the labor market. You
need to implement a much more radical approach which will target new emerging
industries. I was happy to see president Obama announce that the
government is handing out nearly $2
billion for new solar plants, but this is a drop in the bucket,
basically peanuts.

Seventh, I think Mr. Ferguson is right that
we need to simplify the tax code, but I prefer a consumption tax which
does not penalize low income families over any flat income tax. Mr.
Ferguson was coy stating that "Keynesian policies were an abysmal
failure in the past". It wasn't Keynesian policies that led to the 1970s
stagflation episode, but supply shocks and funding the Vietnam war
through expansionary monetary policy.

Finally, one thing
Krugman said on ABC's This Week really struck me. He said he doesn't
like the term 'double-dip' because even of the US economy grows at 1%
but unemployment rises to 10.5%, it won't technically be another
recession, but that doesn't mean much to those who are currently
struggling to find work.

We are at a crossroad. Millions of
unemployed people are losing hope, waiting for policymakers to come up
with a program targeting job growth. Instead, all they are seeing is
political feuding that doesn't address the central core issue - jobs.
It's as if politicians have run out of ideas and go with whatever the
latest poll tells them is the flavor of the day. The lack of leadership
from politicians and business leaders during these unnerving times is
truly disheartening.

Let me end by wishing all my US readers a
Happy Fourth of July. As bad as it gets, never lose hope in America.

If "millions of unemployed people are losing hope, waiting for policymakers to come up with a program targeting job growth," then they had better get comfortable with being unemployed. The biggest myth of all is that the state can do anything (except protect property rights and get out the way) to catalyse incremental economic activity.

Remove minimum wage laws, unemployment benefits, and disolve public sector unions and you'll see the private market create jobs in spades. But then you'll complain probably that everyone is only making 30cents on the dollar of what they used to make. Guess what, at 30cents on the dollar workers would still be OVER PAID, because the Chinese are willing to do it all for 5cents on the dollar.

Hell, right now I'd hire 2 people to help me with things, but I have to be able to pay them $2.50/hr. Not legal here, but with 15% unemployment i bet there are people who would do it. THE GOVT WONT LET THEM WORK!

Public sector is there to cushion the downturn. The whole point of public spending during a crisis is that when busines confidence is low, and they're not hiring, you need something to spur them on. It's not a magic solution, but you can't just count on the private sector alone to get us out of a recession.

That's an open ended statement. But if you're referring to the whether I think that If someone gets $100, that some of that money will go to person #2, then some of that will get spent and go to person #3, thus creating "economic activity", then yes. But that is not the issue.

The problem is when government starts to allocate resources everything gets skewed, which is further compounded by the multiplier effect. Resources continually getting misallocated. This causes many unseen problems (for instance, maybe there would be innovations or services that would exist if private demand drove resources toward where it was needed or wanted). If there's a lag between private resources allocation it's because there is a good reason for it. Whether or not private industry doesn't know where to put money into or to whom, eventually that would get sorted out and deflation allows this to happen. It's not an 'endless loop' as Keynesians think.

For instance, I know people that couldn't afford a house 2 years ago, but bought one this year. And now their spending contributes to the multiplier effect. All possible by way of deflation. But guess what, since they spent less money on the house, they have more money to spend on other things! Fast forward; more recently they bought furniture, got a new car, had money to go on a trip. None of that would have been possible with housing prices of 2006. The money that is being spent by them now is going to people, places, and companies that would not have seen a dime if house prices were as high as they were 4 years ago. Here you have deflation stimulating the economy in ways no central banker can possibly predict, much less imitate.

And it causes many seen problems; People who want to work but can't get jobs. Long term unemployment that we're seeing manifest itself is a result of misallocation of resources. The fact that unemployment is high is b/c the natural market is trying to re-allocate correctly. Instead of allowing this natural progression to happen, you are calling for more government interference. Can you not see but 1 causal step in front of you? Open your eyes, man.

Calling for government to constantly fill any spending gap of private sector reminds me of the furniture, real estate, car, or stock market commercials I constantly see/hear. In short, no matter what "Now is the best time to buy." Umm, no.

You need not worry about bond vigilantes simply Americans shifting assets away from treasuries into another asset classes and you have the same impact, tact on what the vigilantes do on top of that and watch out. I honestly have not seen one article I agree with Leo on other than how screwed pensions are. It just cracks me up that everyone, well mainstream everyone, thinks that it can never happen here because we are America and we are the exception to the rule. We are too big and too smart. The Fed is too strong, blah, blah, blah... Bullshit. The US shifted from long-term financing to short-term financing, in the trillions, show me anywhere in the world where that worked long-term. Eventually this will fall apart and the Fed will go out swinging, but they will lose taking the dollar down with it. BTW, Krugman is a complete idiot he is saying we are entering a deflationary depression because we did not do enough spending, please. I knew he was going to say this when he said, for the stimulus, think of a big number and double it. The proof that the stimulus is not working is evident right now, we are STILL spending billions and the data is rolling over, more will only make the problem worse.

"I was happy to see president Obama announce that the government is handing out nearly $2 billion for new solar plants, but this is a drop in the bucket, basically peanuts."

Solar power = NWO baloney

Show me one solar panel factory that uses solar-generated power to build their solar panels. There is no such critter. All solar panel production facilities draw their power from local power grids whose power comes from plants that burn hydro carbons or nuclear power plants or dams. If you want more solar panel plants you will have to burn more hydro carbons or build more nuclear power plants or dam up more rivers.

Solar panel generated power is NOT sustainable - it is the exact opposite. Solar power is PARASITE power which cannot exist without solar panel plants that are parasites on the local power grid.

Solar panel plants are a New World Order scheme to bankrupt us by throwing scarce resources down a rat hole so a bunch of useless eater Bilderberg and Fabian Society parasites can get their collective rocks off while they bomb the entire world with depleted uranium birth defect bombs and use the hunt for Osama bin Subcontractor as an excuse.

On the other hand I would approve of a solar powered guillotine and recycling thier filthy NWO carcasses into bio diesel.

I'm ignorant on this topic and would appreciate clarification. Are you saying that it takes more energy to produce, service, and operate a solar panel, than one would consume using electricity instead?

I would expect solar panels to reduce strain on power grids, in the long run.

"I'm ignorant on this topic and would appreciate clarification. Are you saying that it takes more energy to produce, service, and operate a solar panel, than one would consume using electricity instead?"

With the US trapped in depression, this really is starting to feel like 1932

By Ambrose Evans-Pritchard Published: 9:33PM BST 04 Jul 2010

"Let us be honest. The US is still trapped in depression a full 18 months into zero interest rates, quantitative easing (QE), and fiscal stimulus that has pushed the budget deficit above 10pc of GDP.

The share of the US working-age population with jobs in June actually fell from 58.7pc to 58.5pc. This is the real stress indicator. The ratio was 63pc three years ago. Eight million jobs have been lost.

The average time needed to find a job has risen to a record 35.2 weeks. Nothing like this has been seen before in the post-war era. Jeff Weniger, of Harris Private Bank, said this compares with a peak of 21.2 weeks in the Volcker recession of the early 1980s.

"Legions of individuals have been left with stale skills, and little prospect of finding meaningful work, and benefits that are being exhausted. By our math the crop of people who are unemployed but not receiving a check amounts to 9.2m.""

Austerity is needed because we can no longer claim with any credibility that current obligations can be serviced, let alone the trillions in new obligations fools like Krugman and Obama propose. Even average Joes with a bit of common sense can understand what econ PhDs seem to ignore -- future generations are not stupid, and intelligent, mobile, high-earners will adjust their output or leave the tax base.

Double the income tax rates, end all discretionary federal spending, try to balance the federal budget, and you find that entitlements and debt service are still too large, and the people left to pay for them will say "No" in a most unpleasant way.

If the system was rigged so that the Fed could conjure up money out of nothing maybe, but (before all those that start screaming at me for not understanding that they can, and have, created money out of thin air, I know how money is created, thanks.) the system only works with the belief that debt needs to be paid back. It's the backbone of the fiat system. They need the plebs to believe that when they sign a loan document, they are obligated to pay the loan back. Once that belief begins to waver, the fiat system would collapse. There is no way the Fed would ever let that belief waver. They might do all sorts of things behind the scenes but the Treasury figureheads will always claim to "have a debt plan" to pay the money back. That is where the limit to borrowing comes from. It's less a monetary amount than a confidence threshold. The Fed and the Treasury is trapped between maintaining credibility that the debt will be repaid and the need to maintain stimulus. Anybody recall Bernanke bringing up deficit concerns? Once the US reaches a point where the debt is at a level where people cannot believe that it will be paid back, the game is up. Although we might have hit the monetary limit of debt issuance, I'm not sure we have yet hit the credibility limit. Some might argue that we are close to that point. I'm not sure we are. But when the "credibility" limit is reached, the Fed will be powerless.

At that point two things will happen:

Either deflation in order to clear the way for more debt growth (fiat system continues) or we go back to the wild wild west.

ugh...whats "austere" about reducing a deficit form 12% of GDP to 9% then 6% then 3%? Any deficit is expansionary as it is spending more than is earned. Why must we be fooled by G increaing or decreasing in relative terms ALL THE TIME. With the accumulated debt hurtling to 300% of GDP in ten years!

What part of the effect of the current political spectrum about the deficit isn't understood here? We know the Fed is sterilising the deficit by the purchasing all kinds of crap. The Fed buys Treasuries plus FRE and FNM and any other paper, giving cash to the sellers who have nowhere else to go but the treasury market.

There is no Treasury "market" it is manipulated by a Fed and cheered on by other "uber communists" like Krugman.

This is an attack on a democracy by the powers that prefer power concentrated in their hands only. Support Q/E and you support further migration to the failed nation state and communism. Just wait for the next "five year plan".

The private sector can create wealth, but right now the private sector is swamped by the sheer volume of deficit spending and financing.

This is not a market, it is a regulated disaster. I recommend you re-read 1984 and think about the PIIGS running the farm and then come up with some reason why the US is not getting distinctly PIIGSy and turning Japanese.

The Government can take money from people and waste. So could you or I, Leo. We have a conscience (I hope) so we prefer not to steal other people's livelihoods.

yes I know I'm talking to myself now (checks for hairs on palms) but really I could hardly bear to get past the intro with some whacked out Fareed with staring eyes claiming that he has the two most important people in the world debating the only two sides that matter. CNN was great in 1991, now its so full of the shit it spouts its lost all credibility.

One last bleat, that link to a post by Mish says it far more eloquently than I could. I will have a go though! :)

If you know theres an axe murderer in your street, breaking into houses..you dont tell him/her to go slower so you can clean up the mess he/she is making. You take him out and stop him/her immediately. This is what people just don't understand. It is not "austerity" or "deficit reduction"... it is the prevention of crime. A crime is defined as anti-social behaviour impacting the property or well being of another. We are living a crime. It has to stop. It is not able to "managed".

Government spending is never additive to economic activity. Krugman and others are blinded by the GNP = C + I + G equation. Yes. Under their formula, if you lower G, GNP or GDP will decrease. So being blinded by the equation, they correctly claim that decreasing government spending will cause GDP to fall.

But the government doesn't produce anything. They can only ever take from one group to give to another. That's not a productive event. That's just a transfer. Cutting government spending means cutting transfers from one section of the economy to the other. This is will not result in a collapse. And given that most of the taxes are income taxes, cutting government spending means cutting the transfer from the productive to the non-productive.

The major economic myth that needs to be refuted is that government spending is additive to a productive economy.

You are exactly right when the government is controlled by crony capitalists. Funneling public money into non productive ventures will only stifle growth in key areas of the economy since it deprives funding where it is truly needed. Hoover, just like Hitler, kick started the economy with stimulus spending on public works projects that still contribute the the economy today but I think these public ventures are limited today due to the publics paradigm shift in thinking over the past 80 years. Today's average schmo seeks instant gratification with a selfish perspective on growth and a sense of entitlement. eg. A light rail system in Michigan or SC will certainly piss anyone off that's not in the path of THAT oncoming train.

Therefore public money must satisfy the largest contributors to GDP. Without new technologies for consumers to spend on, it's unlikely the economy can return to a pre crisis state (minus bubbles). It may be viewed as unfortunate that our society has progressed to tech junkie status but IMO that's exactly the addiction growth depends on.